Monday, September 12, 2011

Unconventional Monetary Policy: From the comments

Special thanks to studentee for this link from Nick Rowe. The discussion is full of goodness, beyond the points raised in my previous post. In particular, I will pull out this assertion and rebuttal from Nick & RSJ.

First Nick:

I am Ben Bernanke. I commit to printing trillions and buying up every single financial asset -- government bonds, commercial bonds, stocks, and new stocks and bonds as issued, and will keep on doing this forever and ever until my NGDP target is met. At this point even rsj says, "OK, that would maybe increase future AD by $1, and increase future NGDP by $1". So now everyone starts spending more, even if it's just a small amount. But that's not an equilibrium expectation either, because we are still not at my NGDP target, so I repeat my commitment, and rsj raises his expectation another $1 when he sees that everyone else has raised their expectation too, and raised their desired spending. And so on.

Roosevelt did it. The Swiss did it. Central banks have been loosening monetary policy and creating inflation throughout history. Did history come to a full stop in 2009?

Half the US seems to be afraid of inflation. All Bernanke has to say is "Yep, I'm going to do whatever it takes to make sure your fears are justified!"

Now RSJ:

The Federal Reserve cannot purchase any financial asset. What the bank can and cannot do is defined in the Federal Reserve Act.

It can purchase obligations of the U.S. government, gold, bills of exchange, and agricultural paper. Adding that all up, you have at most about 7 Trillion or so of assets that the central bank can buy (it does not buy gold today).

After that, there is nothing left for the CB to legally buy.

Compare that to the 60 Trillion or so of U.S. assets that are out there.

Again, this is where knowledge of the institutions is important.

By the way, there is a *reason* why central banks cannot purchase "baskets of output" or "all assets", as you keep insisting.

Even the ECB, which has no risk free assets to purchase, is limited in what it can buy, both legally and effectively (e.g. politically, by the member banks that supply capital to it).

That reason is that should the CB purchase an asset that is defaulted upon, that loss of capital becomes a fiscal transfer from the ECB to the borrower.

That fiscal transfer has to be paid for by someone -- it is not paid for by the central bank, which is an intermediary between those who supply capital to it and its borrowers.

Therefore central banks can only engage in these types of transfers should the capital suppliers allow it.

In the case of the Fed, the capital supplier is the U.S. Treasury, and if the U.S. treasury wanted to make transfers (as under TARP), then it would do so itself, after permission from Congress, as spending needs to be authorized by congress and cannot occur as a result of CB policy.

So the democratic process limits the amount of fiscal policy that central banks can conduct under the guise of monetary policy.

Even if you are confused about the distinction between the two -- the legislators are not confused; which is why they have put strict limits on what central banks can and cannot buy, in order to limit any unauthorized ex-post transfers.

Discriminating minds want to know if Government backed Solyndra debt is (legally) purchasable by Bernanke. Also, how about open swap lines with Mexcico?

posted by winterspeak at
1:46 PM Unconventional Monetary Policy: From the comments

9 Comments:

I'm not a lawyer, so I can't say whether Solyndra debt is legally purchasable.

But it doesn't matter, because the if the government guarantees the debt, then the CB is buying risk-free debt, and no fiscal policy is occurring as a result of the purchase.

Treasury is on the hook. The fiscal policy was made when the government guaranteed the debt -- which was due to an act of congress. As part of their clean energy bill, they authorized a (limited) amount of loan guarantees that the Department of Energy could provide. We provide loan guarantees all the time, all authorized by acts of congress which specify not the only types of recipients but the amount that can be guaranteed.

That's how fiscal transfers are supposed to be done. Who actually buys the debt doesn't matter at that point.

"Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market."

I think the Fed is arguing the swap lines are authorized by 14.e,

"To establish accounts with other Federal reserve banks for exchange purposes and, with the consent or upon the order and direction of the Board of Governors of the Federal Reserve System and under regulations to be prescribed by said board, to open and maintain accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may be deemed best for the purpose of purchasing, selling, and collecting bills of exchange, and to buy and sell, with or without its indorsement, through such correspondents or agencies, bills of exchange (or acceptances) arising out of actual commercial transactions which have not more than ninety days to run, exclusive of days of grace, and which bear the signature of two or more responsible parties, and, with the consent of the Board of Governors of the Federal Reserve System, to open and maintain banking accounts for such foreign correspondents or agencies, or for foreign banks or bankers, or for foreign states as defined in section 25(b) of this Act. Whenever any such account has been opened or agency or correspondent has been appointed by a Federal reserve bank, with the consent of or under the order and direction of the Board of Governors of the Federal Reserve System, any other Federal reserve bank may, with the consent and approval of the Board of Governors of the Federal Reserve System, be permitted to carry on or conduct, through the Federal reserve bank opening such account or appointing such agency or correspondent, any transaction authorized by this section under rules and regulations to be prescribed by the board."

"The Federal Reserve operates these swap lines under the authority of section 14 of the Federal Reserve Act and in compliance with authorizations, policies, and procedures established by the Federal Open Market Committee (FOMC)"

Reading section 14, I think Solyndra debt is covered by 14.a and the swap lines by 14.e

I don't think it's very useful to get too involved about what is and is not allowed.

In a crisis, they will interpret some of those provisions creatively.

The larger point being that Congress, recognizing that purchasing assets and granting loans can lead to fiscal transfers, put strict limits on the central bank to minimize those transfers while still allowing the bank to function as a lender of last resort to other banks and to set interest rates via OMO. Congress prefers to keep that power to itself, and is stingy about delegating it.

Moreover, the FRA was also written in the belief that the government should not purchase private capital, it should purchase its own obligations, for obvious reasons.

Btw, I'm RSJ, but the OpenID implementation in Blogger makes it hard to use my Wordpress OpenID as anything other than the name of my Wordpress blog.

spot on. everything else after the permissible assets which the Fed can buy is TECHNICALLY FISCAL POLICY. Bernanke seems to understand this, which is why he actually argued in 1 academic paper that fiscal policy should dominate monetary policy in crises. But his own statements as a policy maker have been a mess. I explain his 'unconventional monetary policy' and the paradox he faces in a recent JPKE paper (also on my site) Pavlina-Tcherneva.net

studentee: that's what makes sumner so wonderful. reality never enters the equation, so you actually get a clear reading of the theory.

as for nick, well, i asked him what he would do if he expected his life savings to evaporate due to inflation. he said he would take a one year vacation and buy an expensive custom canoe. or maybe kayak. he would also buy a lot of scotch.

"as for nick, well, i asked him what he would do if he expected his life savings to evaporate due to inflation. he said he would take a one year vacation and buy an expensive custom canoe. or maybe kayak. he would also buy a lot of scotch."

"It can purchase obligations of the U.S. government, gold, bills of exchange, and agricultural paper. "

Is the Fed breaking the law then when it has bought all kinds of other things in recent times, and made loans to all kinds of other entities than comercial banks? Do we even know who they are supporting and by how much?